Austerity hurts, but not as much as economic collapse

No one in economics always gets it right. It is very definitely a “learning science” and sometimes there is a cost attached to that, especially for those who make predictions.

The personal cost of not always getting it right can vary from zero to catastrophically high. A classic example of high cost can be found in Yale Professor Irving Fisher’s prediction in 1929, three days before the stock market crashed, that, “stock prices have reached what appears to be a permanently high plateau.”

At the time, Professor Fisher was the best known and most widely respected economist in America. And while he continued to make very valuable contributions to economic theory and policy, his almost comically timed mis-prediction attached itself to his reputation like a living epitaph.

For today’s economists, almost all of whom somehow missed the real estate bubble until it unhorsed our economy and nearly destroyed our financial system, though, the cost has been near zero. In fact, with the exception of some largely unread snarky articles and premature eulogies for the science, along with a few more economist jokes than usual, economics itself has emerged unscathed and unchastened by the experience. That is not a good thing.

We might have thought that the dust-up from all those “oops” predictions would sprinkle some humility on the shoulders of the economics biz. At the very least, we would expect more open discussion about economic policies. But it seems that human nature doesn’t work that way. Apparently, since there was no penalty or cost for getting it wrong, our brains process that as meaning we are always right.

Economics writers and policy analysts who take to the public forum, have, if anything, become more belligerent in promoting their ideas and more likely to identify those who might disagree with them as either mentally impaired or in the active employ of Satan.

A recent example of this can be found in the hyperbole and dizzying spins that have been applied to the federal government’s modest budget cuts under the sequester law. Boring economic theory implications don’t stand a chance in this arena, of course. They’re out of their weight class.

Still, amid all the talk of disastrous consequences of budget trimming, some economic policy analyst might have wondered, “if a 2.5 percent budget cut could have such a huge negative impact on our economy, wouldn’t a 2.5 percent budget increase be enough to stimulate it dramatically? How come we have to spend trillions more?”

The experience of the European economies has been different from ours, of course, but the idea of government budget cuts is still anathema to mainstream economists and policy analysts there. A recent article in one of the most respected, wide-circulation financial dailies reported on the “sad record of fiscal austerity” and declared that “Tens of millions are now suffering unnecessarily.”

The report was buttressed with a chart showing clearly that the countries that had made the deepest government budget cuts experienced the deepest reductions in economic output. Moreover, according to the article, these budget cuts were unnecessary, and instead the result of a European Central Bank becoming unhinged by its Captain Ahab-like obsession with balanced budgets.

While the chart is meant to be dramatic proof of the damaging effects of austerity, no one thought to ask the question, “Well, duh. … What did you expect?” Government budget cuts are painful and whatever their long-term effects might be their initial impact is hurtful to an economy. And the deeper the cuts, the more hurtful they are. No one ever questioned that.

The part that is missing from the picture, though, is that the European countries that adopted austerity programs did so because they had no other choice. Their credit spigots had been turned off and no one was going to lend them any more money. Their only source of funds to keep the lights on was the central bank, and it wasn’t about to underwrite their unrealistic, government supported cradle-to-grave lifestyles.

The economics question to be asked, then, is not whether government budget cuts are painful. Of course they are, just as cutting our household budget reduces our standard of living, or “lifestyle.” The real question, though, is whether austerity programs are more painful than the alternative, which in the case of many European countries was total economic collapse.

The big difference, economic and politically, between Europe and the U.S. is that at this moment, spending cuts are not our only choice. There is no visible crisis; credit markets have not turned off our cash flow spigot; interest rates are still low. To the unquestioning it looks like we could just go on indefinitely spending money we don’t have. Experience tells us, though, it always does.

James McCusker is a Bothell economist, educator and consultant. He also writes a monthly column for the Herald Business Journal.